Goldsholle: NASD Looking at Commission Recapture Arrangements
Speaking at last week’s SIA hedge fund conference, NASD associate general counsel Gary Goldsholle identified commission recapture arrangements as an area of NASD examination and enforcement interest.
Goldsholle described commission recapture as situations where a hedge fund sends trades to an affiliated broker-dealer in order to generate revenue. Using an affiliated broker-dealer "isn’t itself the problem," he explained. "It’s when it becomes part of a collusive scheme, as a way of charging excessive commissions or engaging in wash trades or other activity, that [it] becomes an area of concern for us."
From Goldsholle’s perspective, disclosure alone might not cure the situation. If a broker-dealer and a hedge fund engage in a collusive scheme in order to capture investors’ money through a commission recapture arrangement, disclosure would not be adequate to cure the fraud. "I don’t want people to leave with the impression that simply providing disclosure will in all cases prevent there from being a concern." For example, even if there were disclosure, the fact that you would be charging "six cents or ten cents a share, or engaging in wash trades, would create concerns," he said.
Goldsholle noted that commission recapture has been an issue in the Bayou Management case, but noted the NASD’s "efforts" in the area predated that case.
Speaking of Bayou and commission recapture, check out this client letter sent earlier this month by Hennessee Group, following the apparent Bayou blow-up. In it, Hennessee defends its use of "manager rebates" to pay its one percent advisory fee.
Clients, explained the consulting firm, pay Hennessee a one percent advisory fee. However, hedge funds recommended by Hennessee can pay that fee on behalf of Hennessee clients that invest in the funds under one of two "payment options." First, explained the letter, "the fund can direct brokerage commissions to Hennessee when it executes certain securities transactions through a broker." Alternatively, the fund can pay cash to Hennessee to satisfy the client’s fees. "This payment option is identical to thousands of commission recapture arrangements, therefore not unusual, and does not increase the fees you pay for our services," said Hennessee. The firm noted that the payment option was "entirely elective" to both clients and hedge funds, and is fully disclosed.